Livestock Risk Protection and Price Basis

Tim Eggers, Iowa State University Extension Field Agricultural Economist

September Feeder Cattle

October Feeder Cattle

November Feeder Cattle

A Marketing Plan

A marketing plan should address:– short term survival – long term success– key elements – map to destination

Key Elements of a Marketing Plan

• Marketing objectives• Cost of production • Current market environment• Contingency plans• Flexibility

Pricing Targets

• Establish minimum price objective– Risk tolerance– Your cost of production • Could use Beef Cow/Calf Enterprise Budget

• Your records provide better information

Strategies for Marketing Spring Calves

• Wean, Sell Nov. 1• Background, Sell Jan. 1• Background, Finish, Sell July 15• Wean Sep. 1, Finish, Sell June 1• Wean Nov. 1, Finish, Sell July 1

Wean & Sell Nov. 1• Calves weaned & sold on Nov 1 (550#) • Benchmark strategy • Cost of Production—Cow costs• Market Value Factors– Pre-conditioning– Source verification

Wean & Sell Nov. 1• Risk Management Factors– Forward Contract• What, When, Where, Price

Sale Barn Video Auction

Background & Sell Jan. 1• Wean November 1• background 60 days• Sell at ~670# on January 1• Increased risks– Price risk and opportunity – Rate of gain risk and fleshiness– Mortality and morbidity risk

Background & Sell Jan. 1

• Risk Management Factors– Forward Contract– LRP Insurance• Minimum coverage period is 13 weeks, so insurance

must be purchased as appropriate

Background & Finish

• Previous backgrounded calves put in feedlot January 1 and fed until August 20

• Increased Risks– Price risk– Opportunity cost– Mortality, morbidity– Weather– Feed price

Wean Sep. 1, Finish

• Lower cow costs • More feed yardage costs• Improved quality grade

Risk Management Tools

• Futures market– Hedging– Buy a Put Option

• Forward Contract• Livestock Revenue Insurance – Livestock Risk Protection (LRP)– Livestock Gross Margin (LGM)

Feeder Cattle Futures Contract

• Feeder Cattle Futures Contract (FC)– 50,000 pounds (67 hd- 750# feeder cattle)– Contract months—Jan, Mar, Apr, May, Aug, Sep,

Oct, Nov– Contract expires last Thursday of contract month– Cash settle, no delivery– Margins--$1000

Live Cattle Futures Contract• Live Cattle Futures Contract (LC)– 40,000 pounds (33 - 1200# cattle)– Contract Months—Feb, Apr, Jun, Aug, Oct, Dec– Expires last business day of the contract month– Contract settled by physical delivery of cattle– Margins--$700

Hedging: Money Required

• Commissions vary with broker– Example: $60 per contract =

about 15 cents per cwt. (LC)about 12 cents per cwt. (FC)about 1-2 cents per bu. (Corn)

• Margin Money• Interest on margin money

Basis

Basis = Cash Price - Futures Price

If Cash = $120 and Futures = $110

Basis =

• Estimated basis is a forecast based on history.

Hedge

• Managing price or market risk by taking a position in the futures market opposite to that held in the cash market

• Cash position—33 head of cattle to be marketed in June

• Hedge position—Sell a live cattle contract on the CME

Hedge ExampleCattle ready for market in JuneSells June LC futures at $98.50/cwt in OctoberExpected local basis in June is $0.74Expected hedge price is $99.24/cwt ($98.50 + $0.74)If futures are $95 when hedge is lifted

there will be a $3.50 gain on the futures contract ($98.50 – $95)Cash price will be $3.50 less than expected ($99.24 – $95.74 = $3.50 loss), offsetting the futures gainResult will be expected price of $99.24

Gain offsets loss as long as basis is as expected ($0.74)

LRP Exercise• Cow/calf producer

• End of March wean and sell

• 36 steer calves at 550 lbs

• Buys LRP on September 22 – (26 wks out)

Size of CoverageFutures and options have fixed contract sizes:– Fed cattle: 400 cwt. or about 32 head– Feeder cattle: 500 cwt., 60-100 head

• LRP can be purchased for any number of head or weight

Expiration Date of Coverage

• LRP ending date is fixed. – Insurance contract settles on end date.– Price may change after date of sale.– Market date should equal end date

• Futures or options can be lifted at any time before the contract expires.